Gearing

Gearing, which is synonymous with leverage, can be used in two ways. The first refers to the extent to which a company is funded by debt and can be calculated by dividing its debt by shareholders' funds. A company with a high proportion of debt to equity is highly geared and is more vulnerable to fluctuations in business activity. It presents a higher risk for shareholders. The second meaning refers to the amount of cash spent purchasing an option or a futures contract compared to the value of the position. For example, to buy futures contracts worth $1 million an investor may be required to pay only 20 percent of the price. The more highly geared the trading position the greater the risk that a small change in market prices will wipe out the investment. It also means that a small change in prices can produce large profits.